Mar 012013
 

March 1, 2013

BEST IN CLASS OR BUY THE CLASS II

After the last MTSL Issue (#748) titled “The New Hot Classes” – “super pills” for hepatitis C, and small molecule inhibitors of the novel targets BTK, Pi3K, JAK and PCSK9 – the ideal sequel to that subject is “Best In Class or Buy The Class.” Initially we wrote a long-winded hepatitis C (HCV) history lesson about Vertex and its early success with Incivek, then Gilead buying Pharmasset for an astronomical price, then Bristol-Myers Squibb’s impulsive purchase of Inhibitex and so on.  With the stocks of the hot new classes clearly in vogue we decided to just cut to the chase – do you buy one stock – The Best-In-Class – the true future blockbuster drug, or do you diversify and Buy The Class – a group of stocks in the same therapeutic class more heavily weighted with a Best-In-Class position? In a nutshell, both arguments have equal merit.

In a search for the next “super pill,” a once-a-day pill that is more efficacious and much safer than an injectable drug in an existing multibillion market could and should easily eclipse the existing market leader. The leverage from a blockbuster drug to a small company can lead a period of logarithmic growth. In early-stage human studies, it is rather difficult to predict which compound will emerge as Best-In-Class, and often by then the stock of the leader has usually discounted some level of clinical and commercial success.  PCYC’s ibrutinib clinical success and the meteoric rise in Pharmacyclics’ shares have been well publicized, and the table below provides a rough timeline of drug’s stage of development and stock price performance.  Depending on investors’ time horizon and risk profile, one could have bought PCYC at any clinical phase as the ibrutinib story became de-risked – including this year when the FDA granted it Breakthrough Therapy Designation – and still have been handsomely rewarded. Along the way, the data got stronger, the brilliant JNJ deal was formed, and the therapeutic window widened, as did the gap between the ibrutinib and the competition. That’s what happens with a Best-In-Class drug.

Ibrutinib PCYC % Change

Clinical Path

Year End

Closing Price

Y/Y

Phase I

2009

 $3.14

NA

Phase Ib/II

2010

 $6.08

94%

Multiple Phase II

2011

 $14.82

144%

LT Phase II, 4 Phase III

2012

 $57.78

290%

29 Trials, FDA Grants BTD

12/12-2/22

 $90.37

56%

What about Buy The Class? Initial clinical trials are often exploratory in nature and too small to be considered statistically significant, and while the most sophisticated biotech investors might buy Phase I companies, most do not. Chronic illnesses like HCV often need long-term durability of response and large safety databases to forecast the true commercial potential. Some drug companies cannot wait, as the pool of available real assets is limited – i.e., scarcity value. Such as was the case in the HCV race, history tells us that it is rare for a start-up company with a truly novel compound to remain a standalone entity for very long. Most of the largest pharma/biotech companies derive a majority of their growth from just 1-3 blockbusters. Gilead’s purchase of Pharmasset is a perfect example. Even though it failed, BMS stock has more than recovered since buying Inhibitex, so one might understand why big pharma might take such a seemingly expensive risk. With investors in both Pharmasset and Inhibitex handsomely rewarded in a short period of time, both Best-In-Class and Buy The Class positions made sense. In fact, there were at least three HCV company acquisitions in a period of just three months (Roche/ANDS, GILD/VRUS, BMY/INHX). MTSL does not cover the company, but our best guess is that, despite GILD’s apparent leadership position, if the data for ACHN’s NS5A inhibitor, ACH-3102, pan out, it will not remain independent for long. 

An excellent M&A table from our friends at MP Advisor shows a slew of partnering and takeover activity in the tyrosine kinase class has occurred since 2008. For all of the right reasons, it is a very crowded class. In fact, most of the apparent leaders in the field already have a Big Brother development partnership and/or were acquired since then. Examples include GILD/CGI, CELG/Avila and GILD/YMI. Most of the stocks of the remaining independent companies have done well and reflect the optimistic future of this class of drugs. In the BTK/PI3K inhibitor field, the current leading compounds are ibrutinib, GS-1101, ABT-199 and the recently emerging, IPI-145. Of the four leaders, only IPI-145 remains unpartnered after Infinity re-acquired rights from Takeda’s Millenium Pharmaceuticals (although they still owe MLNM $450 million in milestones on IPI-145 and 7-11% royalties on worldwide sales of all INFI’s PI3K delta/gamma inhibitors).

As noted by PCYC’s impressive valuation, the B-cell inhibitor market is a New Hot Class, and certainly has blockbuster potential. On the other hand, here is where Buy-The-Class might be a bit dangerous. A prominent analyst at a prominent Wall Street firm recently recommended Infinity Pharmaceuticals (INFI) with a beautiful 40-page report.  We are not questioning the fundamental call on IPI-145 (although it was written by INFI’s lead underwriter), as we mentioned the early potential competitive advantages IPI-145 in last week’s Issue.  With the drug industry racing fast to participate in this class combined with the impressive albeit early IPI-145 data presented at ACR and ASH, Infinity is likely to form an attractive corporate partnership. With rising scarcity value of independent assets, the low cost of capital and the PCYC/JNJ deal setting a high bar, the underlying theme to buying INFI is this – it is an inexpensive way to play PCYC. In bull markets such as the current stock market for B-cell inhibitors, investors tend to chase ideas and overlook some important details. (The 40-page report, for example, does not seem to take into account how much INFI owes MLNM, which should reduce the NPV calculation). In a crowded market where stocks already reflect optimism of the Best-In-Class compound, despite obvious benefits of diversification, Buy The Class can still be quite risky. (This is where the unbiased, independent opinions of the MTSL and our BUY LIMITs make sense to us.)

JAKS OR BETTER – FOCUS ON INCY

One “Hot New Class,” in our view, that still offers some opportunity is the JAK inhibitors – notably, MTSL recommended Incyte Pharmaceuticals. Again mentioned in Issue #748, JAK inhibitors have broad clinical potential with implications along multiple signal transduction pathways. JAK inhibitors are under development for the treatment of myelofibrosis, psoriasis, rheumatoid arthritis, polycythemia vera, essential thrombocythemia, myeloid metaplasia and pancreatic cancer. INCY’s Jakafi is the first JAK-inhibitor to be approved by the FDA, for the treatment of intermediate or high-risk myelofibrosis. (The second is Pfizer’s Xeljanz, approved late last year for rheumatoid arthritis.) As a first-generation JAK, Jakafi has a modest therapeutic window, with decent efficacy and an acceptable side effect profile. Launched at the end of 2011, the Jakafi learning curve for INCY and investors has evolved with a new Chief Commercial Officer (from Amgen) focused on physician education as the clinical database for the drug expands. Unlike most of the stocks of the Hot New Classes, and until very recently, INCY shares have lagged.

For the most part, investors believe INCY and Jakafi should be compared to Vertex (VRTX), which has failed to come up with a follow-up HCV drug to its first-generation Incivek. However, we believe INCY should be judged more closely with the successful strategy of Gilead, which has been able to dominate the HIV market for the long-term with multiple products successors and is the true king of oral combination therapies. (GILD just recently entered combination clinical trials with its GS-1101 and its Syk-inhibitor, and also purchased YMI in the JAK-class).

In our view, INCY is and will continue to be the leader of the JAK class. While Jakafi may not be the Best-In-Class, as it is the first-generation, it was the first JAK-inhibitor approved, and its growth now appears to be solid and stable (link to our INCY Special Update note). With over 40 INCY-, Novartis- (Jakavi’s ex-US partner) and investigator-sponsored clinical trials, Jakafi’s indications and therapeutic window will continue to widen. More importantly, several follow-up JAK compounds – with strong partners and wholly owned by INCY – are expected to maintain the company’s leadership position for a long time. The most advanced compound is baricitinib, currently in Phase III trials for rheumatoid arthritis (RA) that, among other characteristics, has the main advantage over Xeljanz as being a once-a-day pill (vs. twice daily). As seen with Lipitor, Crestor and Zocor, there is often room for more than one blockbuster drug in each class, despite minor differences. In “bari’s” case, Eli Lilly is INCY’s partner, and the financial terms of the deal are rather favorable because INCY exercised its option to pay more development costs in exchange for a higher royalty. Bari is also in trials for psoriasis and diabetic nephropathy.

Further evidence of their leadership in JAKs, INCY has initiated three clinical studies with their second generation JAK, INCB39110 in patients with RA, psoriasis and MF. The Company has been quiet on INCB39110, as it is proprietary and completely owned. Due to INCY’s expertise in JAK, experience with Jakafi and now bari, ‘39110 is likely to have meaningful competitive advantages, and possibly become a Best-In-Class compound. Additional details are likely to become available as trials mature and data is presented, but ‘39110’s leverage to INCY’s long-term value, in our view, has yet to be reflected in INCY’s stock. (Most investors are unaware that many of the medicinal chemists at INCY were with CEO Paul Friedman when he ran DuPont Merck Pharmaceuticals, before selling it to DuPont in 1998.) While baricitinib will be second to Xeljanz, in our view, partner Eli Lilly’s osteoporosis franchise and marketing muscle will fully exploit its advantages. Hence, with Jakafi, baricitinib ‘39110, we believe that INCY represents a way to Buy-The-Class and possibly the Best-In-Class as well. INCY is a BUY under $26 with a TARGET PRICE of $34.

As mentioned above, Gilead bought YMI late last year and is likely to begin pivotal studies with YT387 by the end of 2013. Gilead’s powerful resources and determination to be a leader in B-cell disorders, including JAK inhibitors, keeps them high on the radar screen. Sanofi is expected to release initial Phase III data with SAR302503 in Q2:13, although Phase II results (n=31) do not lead us to believe it will be superior to Jakafi. Another up-and-coming company, Belgium’s Galapagos has JAK joint ventures with AbbVie (Phase II, RA) and GSK (Phase I, lupus). (Galapagos’ shares have almost doubled over the past year.) AbbVie, Abbott Lab’s recent pharmaceuticals division spin-off, cannot be ignored with highly competitive compounds in most of the Hot New Classes including HCV, B-cell malignancies and JAK.

The final class mentioned in our last report is the PCSK9 inhibitors for hypercholesterolemia. The leaders are developing monoclonal antibodies – AMGN, MRK, REGN/Aventis, and an earlier antisense program is at ALNY/MDCO. As the largest drug therapeutic class, statins have begun to lose their patent protection, opening up the market for PCSK9 inhibitors. While early data is exciting, it still remains to be seen if lowering LDL via PCSK9 leads to any better outcomes in patients with cardiovascular disease.

OVERCROWDED CLASSROOMS

The Hot New Classes are well in session and, if anything, are very crowded. Since the GILD purchase of Pharmasset, investors have been pouring capital into many of the new leaders  – Best-In-Class drugs, in addition to just Buying The Class. For companies, investors and especially patients, these are truly exciting times – as newer more effective, safer and easier to use “super pills” are changing the paradigm for treatments and potentially “cures” for serious chronic disease. When perusing the landscape, it looks as though the easy money has already been made in several of the classes. While we are on the cusp of approvals of this new generation of blockbuster therapies, many stocks have already discounted not only clinical but commercial success as well. In our opinion, at current share prices, INCY represents an attractive Buy-The-Class and potentially Best-In-Class opportunity.

Most investors are focused on the hot new classes for the right reasons. Our next report, Hit ‘Em Where They Ain’t, will discuss some MTSL Recommendations that are way off the radar screen but may have some transforming events in 2013.